Risk Premium Shocks Can Create Inefficient Recessions

2021 ◽  
Author(s):  
Sebastian Di Tella ◽  
Robert Hall
Keyword(s):  
Business Cycles ◽  
Risk Premium ◽  
Optimal Policy ◽  
Idiosyncratic Risk ◽  
Efficient Allocation ◽  
Price Model ◽  
Aggregate Shocks ◽  
Risk Premiums

Abstract We develop a simple flexible-price model of business cycles driven by spikes in risk premiums. Aggregate shocks increase firms’ uninsurable idiosyncratic risk and raise risk premiums. We show that risk shocks can create quantitatively plausible recessions, with contractions in employment, consumption, and investment. Business cycles are inefficient—output, employment, and consumption fall too much during recessions, compared to the constrained-efficient allocation. Optimal policy involves stimulating employment and consumption during recessions.

The Determinants of the Ex Ante Risk Premiumin Commercial Real Estate

2019 ◽  
Vol 41 (3) ◽  
pp. 411-441
Author(s):  
El i Beracha ◽  
Julia Freybote ◽  
Zhenguo Lin
Keyword(s):  
Real Estate ◽  
Risk Premium ◽  
Predictive Power ◽  
Real Estate Market ◽  
Commercial Real Estate ◽  
Stock Market Volatility ◽  
Switching Regression ◽  
Risk Premiums ◽  
Debt Capital ◽  
Ex Ante

We investigate the determinants of the ex ante risk premium in commercial real estate. Using a 20-year time series and Markov-switching regression, we find that the ex ante risk premium is affected by fundamental and non-fundamental determinants, albeit not symmetrically when risk premiums are increasing and decreasing. In particular, we find that changes in debt capital market conditions have a higher predictive power for changes in the ex ante risk premium when it is increasing, while changes in stock market volatility and commercial real estate market returns have a higher predictive power when the risk premium is on the decline. In addition, changes in commercial real estate sentiment and NAREIT returns can predict changes in the ex ante risk premium; however, the predictive power of these variables varies across property types and risk premium (risk perception) states.

Impact of regulatory announcements on systemic risk in the Indian telecom sector

2018 ◽  
Vol 13 (5) ◽  
pp. 1395-1416 ◽  
Author(s):  
Sushma Priyadarsini Yalla ◽  
Som Sekhar Bhattacharyya ◽  
Karuna Jain
Keyword(s):  
Risk Premium ◽  
Systemic Risk ◽  
Service Providers ◽  
Policy Makers ◽  
Content Type ◽  
Risk Premiums ◽  
Buffering Hypothesis ◽  
Research Findings ◽  
Telecom Sector ◽  
The Impact

Purpose Post 1991, given the advent of liberalization and economic reforms, the Indian telecom sector witnessed a remarkable growth in terms of subscriber base and reduced competitive tariff among the service providers. The purpose of this paper is to estimate the impact of regulatory announcements on systemic risk among the Indian telecom firms. Design/methodology/approach This study employed a two-step methodology to measure the impact of regulatory announcements on systemic risk. In the first step, CAPM along with the Kalman filter was used to estimate the daily β (systemic risk). In the second step, event study methodology was used to assess the impact of regulatory announcements on daily β derived from the first step. Findings The results of this study indicate that regulatory announcements did impact systemic risk among telecom firms. The study also found that regulatory announcements either increased or decreased systemic risk, depending upon the type of regulatory announcements. Further, this study estimated the market-perceived regulatory risk premiums for individual telecom firms. Research limitations/implications The regulatory risk premium was either positive or negative, depending upon the different types of regulatory announcements for the telecom sector firms. Thus, this study contributes to the theory of literature by testing the buffering hypothesis in the context of Indian telecom firms. Practical implications The study findings will be useful for investors and policy-makers to estimate the regulatory risk premium as and when there is an anticipated regulatory announcement in the Indian telecom sector. Originality/value This is one of the first research studies in exploring regulatory risk among the Indian telecom firms. The research findings indicate that regulatory risk does exist in the telecom firms of India.

scholarly journals On the Estimation of Cost of Equity using Industrial CAPM Approach

2020 ◽  
pp. 84-94
Author(s):  
Hassan Raza ◽  
Aijaz Mustafa Hashmi ◽  
Abdul Rasheed
Keyword(s):  
Family Environment ◽  
Risk Premium ◽  
Mutual Fund ◽  
Business Environment ◽  
Agency Cost ◽  
Risk Premiums ◽  
Fund Managers ◽  
Global Investors ◽  
Relationship Of ◽  
Industry Risk

This paper is an attempt to empirically investigate the industrial risk premium and realized return relationship by extending hybrid CAPM of Bodnar, Dumas, and Marston (2004). The inclusion of the industry risk premium offers more sophisticated results. Fama and Macbeth (1973) methodology are applied to test this relationship. The results indicate that there is a positive and significant relationship of the industry risk premium for Pakistan, India, and Brazil, whereas, it is insignificant for China, Russia, and South Africa. It is also seen that other risk premiums are insignificant for the said countries if industry risk premium is considered. The results also indicate that industry risk premium is only significant for those countries where the firms are mostly operated through the family business environment like Pakistan, India, and Brazil. This may lead to conclude that the industry risk premium can be used as the agency cost of minatory shareholders and controlling shareholders. This study provides an insight for the global investors, FPI holders, local and global mutual fund managers, to incorporate this industry risk premium into the existing CAPM framework especially for the countries where the business is managed as a family environment.

scholarly journals Variance risk premia for agricultural commodities

2019 ◽  
Vol 79 (3) ◽  
pp. 286-303
Author(s):  
Wenwen Xi ◽  
Dermot Hayes ◽  
Sergio Horacio Lence
Keyword(s):  
Risk Premium ◽  
Price Volatility ◽  
Risk Premia ◽  
Content Type ◽  
Risk Premiums ◽  
Variance Risk Premium ◽  
Revenue Insurance ◽  
Risk Neutral ◽  
Variance Risk ◽  
Practical Implications

Purpose The purpose of this paper is to study the variance risk premium in corn and soybean markets, where the variance risk premium is defined as the difference between the historical realized variance and the corresponding risk-neutral expected variance. Design/methodology/approach The authors compute variance risk premiums using historical derivatives data. The authors use regression analysis and time series econometrics methods, including EGARCH and the Kalman filter, to analyze variance risk premiums. Findings There are moderate commonalities in variance within the agricultural sector, but fairly weak commonalities between the agricultural and the equity sectors. Corn and soybean variance risk premia in dollar terms are time-varying and correlated with the risk-neutral expected variance. In contrast, agricultural commodity variance risk premia in log return terms are more likely to be constant and less correlated with the log risk-neutral expected variance. Variance and price (return) risk premia in agricultural markets are weakly correlated, and the correlation depends on the sign of the returns in the underlying commodity. Practical implications Commodity variance (i.e. volatility) risk cannot be hedged using futures markets. The results have practical implications for US crop insurance programs because the implied volatilities from the relevant options markets are used to estimate the price volatility factors used to generate premia for revenue insurance products such as “Revenue Protection” and “Revenue Protection with Harvest Price Exclusion.” The variance risk premia found implies that revenue insurance premia are overpriced. Originality/value The empirical results suggest that the implied volatilities in corn and soybean futures market overestimate true expected volatility by approximately 15 percent. This has implications for derivative products, such as revenue insurance, that use these implied volatilities to calculate fair premia.

Individual Consumption Risk and the Welfare Cost of Business Cycles

2007 ◽  
Vol 97 (4) ◽  
pp. 1488-1506 ◽  
Author(s):  
Massimiliano De Santis
Keyword(s):  
Business Cycles ◽  
Idiosyncratic Risk ◽  
Welfare Cost ◽  
Aggregate Fluctuations ◽  
Welfare Gain ◽  
Aggregate Consumption ◽  
Consumption Insurance ◽  
Consumption Risk ◽  
Consumption Fluctuations ◽  
Overall Risk

We measure the welfare gain from removing aggregate consumption fluctuations in a model where each individual faces incomplete consumption insurance. We show that, because this welfare gain is a convex function of the overall consumption risk—aggregate plus idiosyncratic—each individual faces, to gauge the magnitude of the gain, it is important to match individuals' overall risk prior to any policy. In an economy calibrated to match individuals' overall risk, even removing 10 percent of aggregate fluctuations can result in a large welfare gain. Further, large gains do not necessarily depend on the countercyclical nature of idiosyncratic risk. (JEL E21, E32)

HOW TO MEASURE THE IMPORTANCE OF CLIMATE RISK FOR DETERMINING OPTIMAL GLOBAL ABATEMENT POLICIES?

2012 ◽  
Vol 03 (01) ◽  
pp. 1250004 ◽  
Author(s):  
ALEXANDER LORENZ ◽  
ELMAR KRIEGLER ◽  
HERMANN HELD ◽  
MATTHIAS G. W. SCHMIDT
Keyword(s):  
Climate Change ◽  
Climate Policy ◽  
Risk Premium ◽  
Optimal Policy ◽  
Integrated Assessment ◽  
Global Climate ◽  
Functional Relationships ◽  
Abatement Policies ◽  
Marginal Risk

We investigate the importance of explicitly accounting for uncertainty in the determination of optimal global climate policy. We demonstrate that the marginal risk premium determines the importance of adapting the optimal policy to uncertainty. Common integrated assessment models (IAM) of climate change suggest uncertainty has little effect because the marginal risk premium in these models is small. A rigorous investigation of the marginal risk premium and the marginal functional relationships within IAMs allows understanding the non-significance of (thin-tailed) uncertainty as a result of compensating factors in the climate cause-effect chain.

What can increase the default risk in local governments?

2015 ◽  
Vol 83 (2) ◽  
pp. 397-419 ◽  
Author(s):  
Andrés Navarro-Galera ◽  
Juan Lara-Rubio ◽  
Dionisio Buendía-Carrillo ◽  
Salvador Rayo-Cantón
Keyword(s):  
Risk Factors ◽  
Interest Rates ◽  
Risk Premium ◽  
Financial Management ◽  
Local Governments ◽  
Default Risk ◽  
Warning Signs ◽  
Loan Repayment ◽  
Risk Premiums ◽  
Financial Soundness

Concern has been expressed by international organisations and in previous studies about the financial situation of local governments, and the question of debt has been identified as a crucial element in efforts to overcome the current financial crisis. However, the variables that can affect the financial soundness of these governments have not been sufficiently studied, despite their direct relation to the credit risk premium. In this article, we aim to identify risk factors for default by local governments, and provide useful information to municipal financial managers. We conducted an empirical study of 148 Spanish municipalities and analysed data from four years, applying a random effects logistic regression model. Our findings reveal that a lower population density, less dependent population, falling levels of per capita income and the presence of progressive local government are all risk factors for default by local governments. Furthermore, our findings indicate that the general financing structure variable and debt composition and maturity variable do influence the risk of default by local governments. Points for practitioners The findings of this article can provide useful information for managers and politicians responsible for the financial management of local governments, in particular, by enabling them to better understand the risk premiums assigned by banks. Specifically, by identifying the risk factors for default, this article highlights the warning signs of this risk, so that suitable arguments may be expressed in negotiating loan repayment schedules and interest rates, and in designing financial viability and restructuring plans.

scholarly journals Methodology of calculating risk premiums in the environment of the Czech Republic and its comparison with Damodaran

2021 ◽  
Vol 91 ◽  
pp. 01045
Author(s):  
Jiri Kucera ◽  
Lenka Maskova
Keyword(s):  
Czech Republic ◽  
Capital Market ◽  
Risk Premium ◽  
Country Risk ◽  
Foreign Investors ◽  
The Czech Republic ◽  
Risk Premiums ◽  
Us States ◽  
The Us ◽  
The Usa

Investors' decisions are largely influenced by the riskiness of the country. Several different approaches are available to calculate this risk, but even so, the values set by Damodaran are usually used, even for non-US states. The aim of the paper is to propose a methodology for creating a risk premium in the environment of the Czech Republic and then compare it with Damodaran [1]. Methods applicable in the Czech Republic and Damodaran methods are used, then these methods are compared. For Czech as well as foreign investors, the easiest way to obtain a risk premium is to use the company’s investment rating. In the case of determining the risk premium of the Czech Republic, the easiest method is the CRP (country risk premiums) model. If the country’s market does not have a long history or does not have such a developed capital market, it is recommended to apply data from the US capital market. However, there are significant differences in the economy between Europe and the USA, so the data of an European country such as Germany, which has historical risk premium calculations, should be used.

scholarly journals Cross-Sector Style Analysis Of Global Equities Based On The Fama And French Three-Factor Model

2012 ◽  
Vol 11 (2) ◽  
pp. 161
Author(s):  
Heng-Hsing Hsieh ◽  
Kathleen Hodnett
Keyword(s):  
Portfolio Management ◽  
Risk Premium ◽  
Factor Model ◽  
Statistical Significance ◽  
Abnormal Returns ◽  
Risk Premiums ◽  
Portfolio Returns ◽  
Fama And French ◽  
Resource Sector ◽  
Sector Returns

Although the ability of the Fama and French (1993) 3-factor model in explaining style-based portfolio returns have been widely tested, no such test has been conducted on sector-based portfolios. The study conducted by Hsieh and Hodnett (2011) indicate that the resource sector yields significant abnormal returns under the capital asset pricing model (CAPM) over the period from 1999 to 2009. In addition, the book value-to-market ratio and market capitalization are found to have pervasive effects on the pricing of sector returns for global equities. Motivated by this insight, we undertake to test the ability of the Fama and French (1993) 3-factor model in explaining the variations in the global sector returns. Our test results indicate that the market risk premium is the most significant factor that drives the returns in all sectors under review. Although the positive abnormal returns of the resource sector dissipates under the 3-factor model, the industrial sector and the information technology (I.T.) sector yield abnormal returns under the 3-factor model. Unlike the empirical findings on the style portfolios, the signs and statistical significance of the exposures to the value and size risk premiums are not consistent across all sectors. This finding suggests that sector exposures are more unique and distinctive compared to the style portfolios. It could be argued that since most of the style portfolios are directly related to the value and size anomalies, any factor model that incorporates risk premiums on these anomalies would significantly explain the style portfolio returns. However, the ability of such factor model in explaining returns on portfolios formed using methodologies other than style anomalies, such as sector portfolio returns, would be questionable. Taking into account the rising global integration, sector allocation might be more effective in terms of global active portfolio management or international diversification than style allocation and country allocation.

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